Question

Kruger Associates is considering a substantial investment in the stock of McIntyre Enterprises. McIntyre currently (time 0) pays a dividend of $1.7 per share. This dividend is expected to grow at 16 percent per year for the next 3 years and 13 percent per year for the following 3 years. McIntyre’s marginal tax rate is 40 percent. Kruger expects the value of the McIntyre stock to increase by 50 percent between now and the beginning of year 5. If Kruger requires a 13 percent rate of return on investments of this type, what value would Kruger place on the McIntyre stock? Use Table II to answer the question. Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Answer :

Stock Price = Present Value of Dividend and terminal Value

Since terminal growth rate is not given,but stock price increases to 50% (1.50 times)at the end of year 4 (beginning of year 5)

Below is the table showing present value of Dividend :

Year	Dividend	PVF @13%	Present Value of Dividend
0	1.7	1
1	1.972 [1.7 * (1 + 0.16)]	0.884955752	1.745132743
2	2.28752[1.972 * (1+0.16)]	0.783146683	1.791463701
3	2.6535232[2.28752*(1+0.16)]	0.693050162	1.839024684
4	2.99848122[2.6535232*(1+0.13)]	0.613318728	1.839024684
		Total	7.214645813

Price at the end of year 4 (i.e terminal value) = 1.5P0

P0 = Total of Present value of Dividend + 1.5P0 *[1/(1+0.12)^4]

P0 - 1.5P0* [ 1 / (1+0.13)^4] = 7.214645813

P0 - 0.9199780915P0 = 7.214645813

0.0800219085 P0 = 7.214645813

P0 = 7.214645813 / 0.0800219085

= $90.16

Current Value of Stock is $90.16.